Analysts pessimistic as purchasing index shows that manufacturing slacked off in June.

WASHINGTON -- The manufacturing sector slumped expected in June, according to a survey of purchasing managers released yesterday, prompting analysts to lower their expectations of factory output over the rest of the summer.

The analysts' comments came after the National Association of Purchasing Management reported that its index dropped 2.8 points to 48.3% in June -- the lowest level in 18 months.

Analysts had expected the index, which is based on a monthly survey of 300 industrial purchasing managers, to drift down slightly in June but to stay above the benchmark 50% level. A reading below 50% generally indicates the manufacturing sector is contracting.

"Manufacturing has been the weakest part of the expansion this year, and this report suggests that this will continue," said David Kelly, senior economist with the Boston Co. "It's not what people expected."

The index's decline corresponds with three straight monthly declines in new orders for durable goods, reported last week by the Commerce Department, said Edward Campbell, senior economist of Brown Brothers Harriman & Co.

Up until yesterday's report was released, Campbell said, he was willing to dismiss the trend in durables -- a a very volatile data series -- as the result of quirky data. "This report confirms that the manufacturing sector has lost quite a bit of forward momentum," he said.

Despite the index's larger-than-expected decline, the widely held belief of many analysts that the economy will slowly improve throughout the year, after 0.7% real growth in the first quarter, was not significantly undermined.

"This report does not shake my confidence in the continuing vitality of the current expansion," said Alan Gayle, director of short-term investments of Capitoline Investment Service. But he conceded the expansion is weak.

Highly sensitive to swings in consumer demand, manufacturers are quick to cut back production when their inventories swell as they did during the first quarter, Gayle said.

Production levels can rebound quickly with increased consumer spending, which Gayle said he anticipates. "Consumers have not gone back into their shell," he said.

Campbell agreed. He pointed out that overtime hours in manufacturing are currently very high, which makes it relatively easy for businesses to cut production, because it is easier to eliminate overtime hours than lay off workers.

Campbell and other economists predicted that the purchasing managers' index will climb back above 50% around the end of the summer, and stay in a relatively narrow range above that point through the second half of the year.

Analysts said the unexpected decline in the index may mean this morning's June employment report will be slightly weaker than previously anticipated because the manufacturing component of nonfarm payrolls could be weaker.

Jim O'Sullivan, a domestic economist with J.P. Morgan and Co., forecast that payrolls in the manufacturing sector will drop by 20,000 in June, but said the decline could be even greater because the purchasing managers' index fell more than he expected.

The consensus forecast of economists calls for a 150,000 gain in total nonfarm payrolls in June. The employment figures are scheduled for release by the Labor Department this morning.

O'Sullivan predicted the jobs gain may be much less than 150,000, which would make many economists even more pessimistic than they are now. Yet economists are already overly pessimistic, he said, because he thinks the economy will rebound modestly.

"I tend to think pessimism has got to the point where it has gone too far," O'Sullivan said.

The Commerce Department also reported yesterday that construction spending grew 0.5% in May to $453.5 billion, after a revised 0.7% drop in April.